Vonage cut off on stock opening

Web phone firm sees IPO shares plunge

The disappointing Wall Street debut of what might have been the next high-tech darling offered a startling look at how fast opinions can change in the digital age.

Until Wednesday, a buzz surrounded Internet phone provider Vonage Holdings Corp., which offered a promising technology that could radically alter how people communicate.

But on its first day of trading, Vonage was judged to be just another company peddling a me-too commodity. Met with tremendous skepticism, its initial public offering tumbled nearly 13 percent. Shares that were priced at $17 on Tuesday evening shed $2.10 on Wednesday to close at $14.85.

"The biggest concern investors have, and the biggest problem I have, is the level of competition in the voice telephone business," said Todd Rethemeier, a stock analyst at Soleil Securities.

Investors weighed whether the Internet phone company with the quirky ad campaign had long-term potential as a competitor to an emerging crop of free Internet calling services, and from established players like cable companies that offer an array of Web services, including voice.

"Vonage was designed to be a low-cost alternative to phone service, and that's what consumers want," said Maribel Lopez, an Internet analyst at Forrester Research.

But while Internet phone service offers a host of easily managed features, cable operators brushed aside those benefits by focusing on the price, Lopez said. They "did a great job of saying it's just digital voice."

On top of that, "investors see Internet phone service as a free play," added Rob Enderle, principal analyst for the Enderle Group.

He compared Vonage to another popular Internet phone service, Skype, which is free as long as both parties have downloaded the software and talk to each other through their computers. Skype was purchased by eBay last year for $2.6 billion.

"The market has come to think of Skype as what people are seeking" for Internet phone calls, Enderle said. If Vonage offered its IPO last year, in the wake of eBay's purchase of Skype, "I'm not sure investors would have known the difference between the two services" and Vonage would likely been successful simply because it is an Internet voice service.

There are primarily three flavors of Internet phone providers. The first, including Vonage, are considered phone-line replacement companies. They use an adapter to plug a phone into an existing high-speed Internet connection.

The second type of service includes Skype and new "chat" offerings from Google, Yahoo and America Online. These are computer-to-computer connections, where a microphone and headset are plugged into a computer. These services are typically free.

The third service comes from Internet service providers like AT&T Inc. and Comcast Corp. The ISPs have the greatest potential for drawing new customers, Lopez said, because they can bundle voice into the monthly Internet bill.

Comcast expects to have 1 million Internet phone customers by year's end, Lopez said. It already has added 220,000 in the first quarter.

Overall, Internet phone service is expected to grow considerably as more households adopt high-speed Internet service.

JupiterResearch forecasts that by 2010, 20.4 million households will subscribe to broadband phone service, up from only 3 million households at the end of 2005.

Vonage is the most popular, with more than 1.6 million subscribers, and users pay about $25 a month for the service.

Lopez estimates there may be as many as 4 million Voice over Internet protocol customers--known as VoIP--right now, representing more than 2 percent of U.S. households.

Rethemeier said voice service eventually will be free.

"All Vonage has is voice service and a brand name" and does not provide Internet service, he said.

Longer term, he thinks Vonage could make changes to its business model and move toward an advertising supported phone service to sharply reduce the costs for customers. A voice ad could be played before a call is placed, for instance, or ads could pop up on a computer screen, he said.

So why did Vonage go public in such a competitive and rapidly changing environment?

There has been speculation that Vonage was seeking a buyer, but none emerged, said Albert Lin, a stock analyst at American Technology Research. With no buyer, it needed the IPO to raise funds in order to grow, he said.

Vonage has yet to turn a profit and it spends aggressively on advertising to maintain its lead as the nation's top VoIP provider.

Vonage spent $331.7 million on marketing during 2005 and the first quarter of 2006, according to a filing with the Securities and Exchange Commission. During that time, the company had revenues of $388.1 million and an operating loss of $346.5 million.

Based on an IPO price of $17, Vonage wanted to raise $500 million and use the cash to expand, including funding its marketing expenses and covering its operating losses, the filing said.

Vonage and other companies specializing in Internet phone service have spent heavily on advertising to build their brands and increase awareness of their services. But that spending has led to "a land grab mentality" that could threaten their business models, the Jupiter report said.

Vonage, one of the Internet's largest advertisers, "should take particular care that it is spending wisely," the report said.